‘An ESG score does not support the basic principles of ESG investing if it considers risk alone.’ That is the message from Doug Peterson, president and CEO of S&P Global, a leading provider of ESG company ratings.
In an open letter, he argues that instead of simply looking at risk, ratings must take a more holistic approach – measuring the positives that companies deliver as well as the risks posed by ESG issues. ESG scores must be about impact, he says.
‘It will be impossible for ESG scores to support progress on sustainability goals if measuring impact is not an integral part of an ESG assessment,’ writes Peterson. ’Alongside impact, it is prudent to consider risk, such as future carbon pricing or physical risks, as part of this assessment. [But] I would argue that an ESG score does not support the basic principles of ESG investing if it considers risk alone.’
Addressing the long-standing issue of just how different ESG scores are from one provider to the next, Peterson argues that this is not necessarily a bad thing.
‘How can ESG scores be so different from one another?’ he asks. ‘The answer is that they are trying to measure different things. There are a number of different approaches or methodologies for assessing the performance of a company against ESG criteria.
‘For example, it could be argued that climate is the single greatest issue for our society, and this should receive the greatest consideration when assessing a company. Others may take a different view, considering diversity and inclusion or a living wage policy to be of equal importance to a net-zero strategy. Perhaps these differences are to be welcomed – market participants often value a diversity of opinions to support their decision-making.’
Instead of trying to align scores from different providers, what Peterson says is needed is greater transparency: ‘Transparency ensures there is clarity on where and why there are differences of opinion.’
Impact and transparency
Despite having proliferated in recent years, the ESG ratings market is still young and, while many on the buy side subscribe to a number of different ratings agencies, investors understand the limitations of such scores and do their own ESG research in-house.
As Deirdre Cooper, portfolio manager on Ninety One’s $3.4 bn Global Environment Strategy Fund, recently told IR Magazine in an interview for the upcoming spring 2022 issue: ‘We read ESG research just like we read sell-side research, but we absolutely never fully implement sustainability by simply eliminating the bottom X percent on an ESG score basis.’
As the ESG ratings industry grows and evolves, Peterson says the focus needs to be on two specific elements: transparency and impact, which he argues will be essential to unlocking further growth, progress on sustainable goals and market confidence.
‘And why does this focus on impact and transparency for ESG scores matter to the wider world? To focus on climate, two thirds of the largest companies around the world have at least one asset at high risk because of the physical hazards created by a warming climate and yet we are not on track to meet the goals of the Paris Agreement,’ writes Peterson.
‘To change this, there must be global acceleration and scaling of action. The investment community is responding to this need, with more than half the world’s assets under management committed to net-zero by 2050. But these commitments need to be realized. It is essential that investors have access to the most rigorous and credible tools to support their decision-making as they seek to make progress toward meeting these commitments.’